Federal regulator turned tough after Freddie Mac scandal

November 24, 2004

Report details OFHEO's efforts to pursue Fannie Mae

By Samantha Peterson Inman News

A publicly released report that is no longer readily available alleges the federal regulator overseeing mortgage giants Fannie Mae and Freddie Mac resolved to become more aggressive in investigating accounting practices after failing to uncover irregularities at Freddie Mac.

The report by the Department of Housing and Urban Development's inspector general said the Office of Federal Housing Enterprise Oversight launched a strategy of negative publicity about the companies after lawmakers questioned the regulator's effectiveness.

Freddie Mac rattled investors last year with a $5 billion earnings restatement, a $125 million fine and the replacement of top executives, stemming from its accounting mishaps. Freddie Mac's restatement was humiliating, OFHEO Deputy Director Stephen Blumenthal told investigators.

Blumenthal also told investigators he believed the agency was afraid of being a tough enforcer in the past and was more interested in being collegial with the companies it regulated. "Well, that's all over now," he told investigators, according to the report. Blumenthal also said he told the agency's examiners to "write those traffic tickets."

Blumenthal talked to his staff about how announcements by public officials could hurt Fannie Mae's stock and help make the company submit to the regulator's will, according to the report.

The report states that "evidence and testimony raises questions about the substance and credibility of certain OFHEO enforcement actions, and the motivation behind such actions."

Fannie Mae's accounting practices came to light in a 211-page report OFHEO released earlier this year. The report, which alleges pervasive accounting problems at the company, has prompted Congressional hearings, a formal investigation by the Securities and Exchange Commission and a round of shareholder lawsuits.

The HUD report originally was released Friday by the office of Massachusetts Rep. Barney Frank, the top Democrat on the House Financial Services Committee. Frank briefly posted the report on a House Web site, but a spokeswoman for the committee said the report is no longer available online and is not available from the committee. She referred all requests for the report to HUD's inspector general's office.

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A spokesman for HUD's inspector general's office referred all report requests to its Freedom of Information Act office. He said he knew nothing about it being posted online, and said a formal FOIA request was required. The agency is required to respond to such requests within 20 days.

"The view inside of OFHEO provided by this report is very troubling," Frank said in a statement. "The senior management of OFHEO appears to have run roughshod over the judgment of professional staff and seriously compromised OFHEO's credibility as a financial regulator."

OFHEO spokeswoman Stefanie Mullin said: "We consider this matter closed and will not be diverted from the important safety and soundness concerns before this agency."

OFHEO Director Armando Falcon in a statement last week expressed his satisfaction with the report's conclusion that he followed the law and acted within his authority. Despite the agency's criticism, the inspector general's report generally concludes that Falcon has broad discretion to release information.

OFHEO was created to oversee Fannie and Freddie, two of the nation's largest financial institutions. Both are shareholder-owned but chartered by the federal government to maintain a constant flow of mortgage funds for the nation's housing market. The two corporations securitize and either resell or own a substantial portion of the outstanding home mortgage debt in the United States. The two companies are vital to the housing industry because the secondary market helps increase the liquidity of mortgage funds, making home loans more widely available.

Fannie Mae executives have defended their accounting principles in question. The company last week said it would have to report a $9 billion loss if the SEC decides the accounting methods were improper.

Some observers have speculated that President Bush's re-election, along with Fannie's current woes and Freddie's past scandal have laid the groundwork for substantive reform of the two companies.

Peter Wallison, a resident fellow at the American Enterprise Institute, doesn't believe the recent report will significantly impact reform efforts or hamper OFHEO's ability to continue investigating Fannie. He pointed to the Congress vote Monday to grant the agency its full budget request of $59.2 million, an increase of about 50 percent.

"The fact that they go their full appropriation really indicates that whatever happens, the agency will continue with their analysis of Fannie's financial statements," Wallison said.

House and Senate negotiators left out a proposal that would have withheld $10 million until Falcon was replaced, but a report accompanying the appropriations bill urged President Bush to act quickly in replacing Falcon and his deputy. Some believe the report is unflattering to the two, but won't prove fatal.

The special status Fannie and Freddie enjoy as government-sponsored entities includes numerous perks, such as discount-cost borrowing from the federal government and relief from SEC reporting requirements as well as local and state tax exemptions. A Congressional Budget Office report earlier this year estimated the government sponsorship of Fannie, Freddie and the Federal Home Loan Banks was worth about $23 billion in 2003.